Momentum : Stay Invested

Although the global environment is challenging, uncertainties about growth are acute and a period of consolidation in markets is now likely. The sharp bounce in the past month, the powerful underlying support from monetary policy, continuing steady albeit subdued growth from the major economies, and the easing of the worst of the collapse in commodity markets and financial stresses all make for an improved fundamental backdrop to markets.

Combined with still reasonable valuations across equities and parts of the credit sector, we remain of the opinion that markets will make further progress in the next year and investors should use opportunities of weakness to add risk to portfolios.

As we have been saying all year following sharp falls in equity markets, investors should stay invested; we believed that markets were discounting many of the uncertainties driving investor fears and that the falls in the preceding few weeks represented a very good opportunity to add to risk in portfolios.

Since then there has been a sizeable rally in risk assets, led by those markets that had fallen the furthest in the past year. Commodity markets, especially energy and industrial metals, had been in virtual free fall for 18 months but since late January the oil price has recovered by almost 50% to around $40 per barrel for Brent crude and key metal iron ore is up by over 50%; other metals have risen less sharply but nevertheless very significantly, including copper up by 17% from its lows.

It’s no coincidence that emerging equity markets, many of which are heavily dependent on energy and metals production and therefore highly sensitive to commodity prices, turned on the same day that the oil price bottomed. Since then they have since returned 17% in USD terms, led by Brazil, up almost 50% from the low. Commodity dependent currencies have also rallied sharply, with the Australian dollar, Canadian dollar and South African rand up by around 10% and the Brazilian real and Russian rouble by close to 15%. Developed equity markets reached a low point in mid-February, since then they have recovered by 11%, led by Europe and Japan.

Credit markets have fully participated in the improved sentiment and market recovery, with returns since mid-February ranging from 2% in high grade credit to 6% in emerging market debt and almost 9% in high yield bonds, whereas government bond markets, where yields had fallen sharply as investors turned to traditional safe havens in a time of rising uncertainty, have sold off, with yields on 10-year government bonds rising by some 20bps in the US, UK and Germany.

Other than with hindsight, identifying the timing and reasons for turning points in markets is never easy. Many markets had become heavily oversold and were discounting recessionary conditions to persist globally for some time; continuation of the deep bear market in oil and commodities was the widespread consensus view, and financial stocks were reflecting fears of global systemic problems which in reality did not exist. As we noted in mid-February, many markets had fallen by over 20% from the 2015 peaks and valuations had improved materially.

Aside from sentiment, there have been some clear positive developments in recent weeks. Data from developed economies has generally pointed to signs of continuing modest, but sustainable growth in economic activity, with the slowdown in manufacturing showing few signs of spilling over into the key service and consumer sectors.

Fears of a sharp slide in growth in China and possible further devaluation of the renminbi have proved unfounded, with the administration reaffirming its growth target of 6.5 – 7% this year, the central bank easing monetary policy and the currency broadly stable. In the oil market, some of the largest OPEC and non-OPEC producers have been in discussions to curb production while shale oil production in the US is declining.

Importantly, the European Central Bank (ECB), which had been expected to ease policy further at its March 10th meeting, over-delivered with some surprise elements of a renewed major monetary stimulus package. As expected the ECB pushed the interest rate on its deposit facility further into negative territory, but offset the impact on banks’ profitability in part by introducing a new series of targeted longer-term refinancing operations (TLTROs) which will offer 4-year funding to banks at rates as low as the ECB’s own deposit rate of -0.4%. In addition the ECB cut other interest rates, increased the monthly purchases in its asset purchase programme by €20bn to €80bn per month, and included for the first time investment grade euro-denominated bonds in eligible assets for its regular purchases.

There is no question that the ECB’s moves provide strong support to European asset values. At the same time the Bank of Japan has made it clear that it will keep monetary policy exceptionally loose for a long time ahead, while the all-important US Federal Reserve has become decidedly more dovish in tone, referring to concerns about the slowdown in growth globally and effective tightening of financial conditions caused by market turbulence.